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What is Secur1tisat1qn

What is Secur1tisat1qn

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Published by: SAMSUKM.59 on Oct 14, 2009
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WHAT IS SECUR1TISAT1QN 
 Securitisation of debt or asset refers to the process of liquidating the illiquid 
and-ibng 
termassets like loans and receivables of financial institutions like banks by issuing marketable securities
againot 
them, in other words, it is a technique by which a long term,non-negotiable and high valued financial asset like hire purchase is converted into securities of small values which can be tradable in the market just like shares?)Thus, it is nothing but a process of removing long term assets from the balance sheet of alending financial institution and replacing them with
 
 I 
 Asset securitization is the processof separating certain assets from the balance sheet and using them as collateral for theissuance of securities. Securities may then be rated and sold based upon the economicquality of the assets. Raising funds through the sale of this commercial paper can provide substantial savings over the cost of traditional term loans. A technique whereby assets are converted into securities, which are in turn converted intocash on
m ongoing 
basis, with a view to allow for increasing turnover of business and  profit, is
known
as asset 
 securitization. The technique provides for flexibility in yield, pricing pattern, issue risk 
and marketability
of instruments, which is to the advantage of both borrowers and lenders. The process of trading in the securities that are created on thebacking of pools of mortgage Voans from banks and financial institutions is called asset  securitization. Mortgage loans include
housing 
 Joans, car and truck loans, credit card receivables, trade receivables, etc. "Securitization", in its widest sense, implies every such process which converts
a
 financial relation into a transaction. Examples include securitization of relationships such as commercial paper,
whkh
 securitizes a trade debt. It is a device of structured financing where an entity seeks to pool together its interest inidentifiable cash flows over time, transfer the same to investors, either with or without the support of further collaterals, and thereby achieve the purpose of financing. Though theend-result of securifatfion is fin&icing, it is not "financing" as such, since the entity securitizing its assets is not 
borrowing 
but selling a stream of cash flows that was otherwiseto accrue to it.
the capital adequacy ratio. Capital adequacy ratio can
also
be improved by replacing the loan assets with the lesser risk weighted assets. Thus, the removal of assets fromthe Balance Sheet under a true sale improves the capital adequacy norms.(iv) Spreading of Credit Ris Securitisation
 facilities
the spreading of credit risk to different parties involved in the process of securitisation. In the absence of securitisation, the entire credit risk associated with a particular financial transaction has to be borne by the originator himself. Now, the originator is able to diversify the risk factors among the various parties involved in securitisation. Thus, securitisation helps to achieve diversification of credit risks which are greater in the case of 
medium
term and long term loans. Thus,it is used as tool for risk management 
(v)
 Lower Cost of Funding 
 
 In vie
o
enhancement of cash flows and diversification of risk factors, securitisation enables the originator to have an easy access to the securitiesmarket at debt ratings higher than its overall corporate rating. It means that companies with low credit raring can issue asset backed securities at lower interest cost due-to high credit rating on such securities. This helps it to secure funds at lower cost. Moreover/ the criteria for choosing the pool of assets ensures an efficient cost of funds. In the present context of scarcity of  funds and higher interest rates, securitisation provides a good scope for cheap funding.
(ui) Provision of Multiple Instruments
From the investor's point of view, securitisation provides multiple new investment instruments so as to meet the varying requirements of theinvesting public. It also offers varieties of instruments for other financial intermediaries Jike mutual funds, insurance companies, pension funds etc. giving them many choices.
(vii) Higher Rate of Return ML
When compared to traditional debt securities like bonds and debentures, securitised securities offer better rate of return along withbetter liquidity. These instruments are rated by good credit rating agencies and hence more attractive. Being structured assets based securities, they offer more protection and yield a good return. The bankruptcy/winding up othe originator does not affect the investors since the payment is guaranteed 
by the SPY. . liquid cash through the issue of securities against them. Under securitisation, a financial institution pools its illiquid, non-negotiable and long term assets, creates securitiesagainst them, gets them rated and sells them tp_ investors, It is an ongoing process in the sense that assets are converted into securities, securities into cash, cash into assets and assets into securities and  so on.Generally, extension of credit by banks and other financial institutions in the form of bills purchase or discounting or hire purchase financing appears as an asset on their balance sheets. Some of these assetsare long term in nature and it implies that funds are locked up unnecessarily for an undue long period. So, to carry on their lending operations without much interruptions, they have to rely upon variousother sources of finance which are not only costly but also not available easily. Again, they have to bear the risk 
of the credit outstandings. Now, securitisation is a
readymade solution for them. Securitisation helps them to recycle funds at a reasonable cost and with less credit risk. In other words, securitisation helps to remove these assets from the balance sheets of  financial institutions by providing liquidity through tradable financial instruments. Again from another angle also, securitisation is a boon to financial institutions. From the risk management point of view, the lending financial institutions have to absorb the entire credit risk by holding thecredit outstandings in their own portfolio. Securitisation offers a good scope for risk diversification. It is worthwhile to note that the entire transaction relating to securitisation is carried out on the asset side of the Balance Sheet. That»« one asset (ill-liquid) is converted into another asset(cash). Definition As stated earlier, securitisation helps to liquify assets mainly of medium and long term loans and receivables of financial institutions. The concept of securitisation can be defined as follows:"A carefully structured process whereby loans and other receivables are packaged, underwritten and sold in the form of asset backed securities".
 
Yet another simple definition is as follows:"Securitisation is nothing but liquifying assets comprising loans and receivables of an institution through systematic issuance of financial instruments". According to Hendersen, J. and Scott, J.P. "Securitisation is the process which takes when a lending institution's assets are removed in one way or another from the balance sheet of that lending institution and are funded  Instead, by investors who purchase a negotiable financial instrument evidencing this indebtedness without recourse, or in some cases wttti 11. ... J^
(vllt) Prevention of Idle Capital 
 In the absence of 
 spniritisntirm.
canl+al wnut 
 LIMITATIONS The use of securitization as
a
viable financial service, has the following limitations; Debility to Central Bank  Securitization process may lead to diminishing of the importance of banks in the financial intermediation
 process,
by
causing 
reduction in the proportion of financial 
assets
and 
liabilities
held by banks. This would in turn render more difficult, the execution of the monetary policy in countries where central banks operate through variable minimum reserverequirements. A decline in the importance of banks could also weaken the relationshipbetween
lenders
and borrowers, particularly in countries where banks are predominant in theeconomy. Heightened 
Volatility
The transformation of non-liquid loans into liquid securities, facilitated by the processof securitization, may
lead to an
increase in the volatility of asset values, althoughcredit enhancements could lessen this effect.
 Moreover,
the volatility could beenhanced by events extraneous to variations in the credit standing of the borrower. A predominance of assets, with readily ascertainable market values, could, even in certai circumstances,
 promote
liquidation, as opposed to
the
 going-concern concept for valuing banks. Pressure on Profitability Securitization process might lead to some pressure on the profitability of banks if non-banking financial institutions, exempt from capital requirements, were to gain acompetitive advantage in investment in Sectaitized assets.
 Eroding Capital Base
 Securitization could 
lead to a decline in the total capital employed in the banking  system,
thereby
increasing th< financial fragility of the financial system as a whole,both nationally and internationally. With a substantia capital base, credit tosses canbe absorbed by the banking system. But a smaller capital base will entail large lossesto be shared by fewer. This concern applies, not necessarily in all countries, but 

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